Variable Public Good Quantities E.g. how many broadcast TV programs, or how much land to include into a national park.

Variable Public Good Quantities E.g. how many broadcast TV programs, or how much land to include into a national park. c(G) is the production cost of G units of public good. Two individuals, A and B. Private consumptions are x A, x B.

Variable Public Good Quantities Budget allocations must satisfy

Variable Public Good Quantities Budget allocations must satisfy MRS A & MRS B are A & B’s marg. rates of substitution between the private and public goods. Pareto efficiency condition for public good supply is

Variable Public Good Quantities Pareto efficiency condition for public good supply is Why?

Variable Public Good Quantities Pareto efficiency condition for public good supply is Why? The public good is nonrival in consumption, so 1 extra unit of public good is fully consumed by both A and B.

Variable Public Good Quantities Suppose MRS A is A’s utility-preserving compensation in private good units for a one-unit reduction in public good. Similarly for B.

Variable Public Good Quantities is the total payment to A & B of private good that preserves both utilities if G is lowered by 1 unit.

Variable Public Good Quantities is the total payment to A & B of private good that preserves both utilities if G is lowered by 1 unit. Since, making 1 less public good unit releases more private good than the compensation payment requires  Pareto-improvement from reduced G.

Variable Public Good Quantities Now suppose

Variable Public Good Quantities Now suppose is the total payment by A & B of private good that preserves both utilities if G is raised by 1 unit.

Variable Public Good Quantities Now suppose is the total payment by A & B of private good that preserves both utilities if G is raised by 1 unit. This payment provides more than 1 more public good unit  Pareto-improvement from increased G.

Variable Public Good Quantities Hence, necessarily, efficient public good production requires

Variable Public Good Quantities Hence, necessarily, efficient public good production requires Suppose there are n consumers; i = 1,…,n. Then efficient public good production requires

Demand Revelation A scheme that makes it rational for individuals to reveal truthfully their private valuations of a public good is a revelation mechanism. E.g. the Groves-Clarke taxation scheme. How does it work?

Demand Revelation N individuals; i = 1,…,N. All have quasi-linear preferences. v i is individual i’s true (private) valuation of the public good. Individual i must provide c i private good units if the public good is supplied.

Demand Revelation n i = v i - c i is net value, for i = 1,…,N. Pareto-improving to supply the public good if

Demand Revelation n i = v i - c i is net value, for i = 1,…,N. Pareto-improving to supply the public good if

Demand Revelation If and or and then individual j is pivotal; i.e. changes the supply decision.

Demand Revelation What loss does a pivotal individual j inflict on others?

Demand Revelation What loss does a pivotal individual j inflict on others? If then is the loss.

Demand Revelation What loss does a pivotal individual j inflict on others? If then is the loss.

Demand Revelation For efficiency, a pivotal agent must face the full cost or benefit of her action. The GC tax scheme makes pivotal agents face the full stated costs or benefits of their actions in a way that makes these statements truthful.

Demand Revelation The GC tax scheme: Assign a cost c i to each individual. Each agent states a public good net valuation, s i. Public good is supplied if otherwise not.

Demand Revelation A pivotal person j who changes the outcome from supply to not supply pays a tax of

Demand Revelation A pivotal person j who changes the outcome from supply to not supply pays a tax of A pivotal person j who changes the outcome from not supply to supply pays a tax of

Demand Revelation Note: Taxes are not paid to other individuals, but to some other agent outside the market.

Demand Revelation Why is the GC tax scheme a revelation mechanism?

Demand Revelation Why is the GC tax scheme a revelation mechanism? An example: 3 persons; A, B and C. Valuations of the public good are: $40 for A, $50 for B, $110 for C. Cost of supplying the good is $180.

Demand Revelation Why is the GC tax scheme a revelation mechanism? An example: 3 persons; A, B and C. Valuations of the public good are: $40 for A, $50 for B, $110 for C. Cost of supplying the good is $180. $180 < $40 + $50 + $110 so it is efficient to supply the good.

Demand Revelation Assign c 1 = $60, c 2 = $60, c 3 = $60.

Demand Revelation Assign c 1 = $60, c 2 = $60, c 3 = $60. B & C’s net valuations sum to $( ) + $( ) = $40 > 0. A, B & C’s net valuations sum to $( ) + $40 = $20 > 0.

Demand Revelation Assign c 1 = $60, c 2 = $60, c 3 = $60. B & C’s net valuations sum to $( ) + $( ) = $40 > 0. A, B & C’s net valuations sum to $( ) + $40 = $20 > 0. So A is not pivotal.

Demand Revelation If B and C are truthful, then what net valuation s A should A state?

Demand Revelation If B and C are truthful, then what net valuation s A should A state? If s A > -$20, then A makes supply of the public good, and a loss of $20 to him, more likely.

Demand Revelation If B and C are truthful, then what net valuation s A should A state? If s A > -$20, then A makes supply of the public good, and a loss of $20 to him, more likely. A prevents supply by becoming pivotal, requiring s A + $( ) + $( ) < 0; I.e. A must state s A < -$40.

Demand Revelation Then A suffers a GC tax of -$10 + $50 = $40, A’s net payoff is - $20 - $40 = -$60 < -$20.

Demand Revelation Then A suffers a GC tax of -$10 + $50 = $40, A’s net payoff is - $20 - $40 = -$60 < -$20. A can do no better than state the truth; s A = -$20.

Demand Revelation Assign c 1 = $60, c 2 = $60, c 3 = $60.

Demand Revelation Assign c 1 = $60, c 2 = $60, c 3 = $60. A & C’s net valuations sum to $( ) + $( ) = $30 > 0. A, B & C’s net valuations sum to $( ) + $30 = $20 > 0.

Demand Revelation Assign c 1 = $60, c 2 = $60, c 3 = $60. A & C’s net valuations sum to $( ) + $( ) = $30 > 0. A, B & C’s net valuations sum to $( ) + $30 = $20 > 0. So B is not pivotal.

Demand Revelation What net valuation s B should B state?

Demand Revelation What net valuation s B should B state? If s B > -$10, then B makes supply of the public good, and a loss of $10 to him, more likely.

Demand Revelation What net valuation s B should B state? If s B > -$10, then B makes supply of the public good, and a loss of $10 to him, more likely. B prevents supply by becoming pivotal, requiring s B + $( ) + $( ) < 0; I.e. B must state s B < -$30.

Demand Revelation Then B suffers a GC tax of -$20 + $50 = $30, B’s net payoff is - $10 - $30 = -$40 < -$10. B can do no better than state the truth; s B = -$10.

Demand Revelation Assign c 1 = $60, c 2 = $60, c 3 = $60.

Demand Revelation Assign c 1 = $60, c 2 = $60, c 3 = $60. A & B’s net valuations sum to $( ) + $( ) = -$30 < 0. A, B & C’s net valuations sum to $( ) - $30 = $20 > 0.

Demand Revelation Assign c 1 = $60, c 2 = $60, c 3 = $60. A & B’s net valuations sum to $( ) + $( ) = -$30 < 0. A, B & C’s net valuations sum to $( ) - $30 = $20 > 0. So C is pivotal.

Demand Revelation What net valuation s C should C state?

Demand Revelation What net valuation s C should C state? s C > $50 changes nothing. C stays pivotal and must pay a GC tax of -$( ) - $( ) = $30, for a net payoff of $( ) - $30 = $20 > $0.

Demand Revelation What net valuation s C should C state? s C > $50 changes nothing. C stays pivotal and must pay a GC tax of -$( ) - $( ) = $30, for a net payoff of $( ) - $30 = $20 > $0. s C < $50 makes it less likely that the public good will be supplied, in which case C loses $110 - $60 = $50.

Demand Revelation What net valuation s C should C state? s C > $50 changes nothing. C stays pivotal and must pay a GC tax of -$( ) - $( ) = $30, for a net payoff of $( ) - $30 = $20 > $0. s C < $50 makes it less likely that the public good will be supplied, in which case C loses $110 - $60 = $50. C can do no better than state the truth; s C = $50.

Demand Revelation GC tax scheme implements efficient supply of the public good.

Demand Revelation GC tax scheme implements efficient supply of the public good. But, causes an inefficiency due to taxes removing private good from pivotal individuals.